No, Really!

Banks Really Are Different Five Years After the Financial Crisis

Still think our dysfunctional financial system hasn’t changed a bit since the day of the cataclysm five years ago? On debt, consolidation, and consumers, Daniel Gross explains why you’re wrong.

Five years ago Monday, I sprinted through Midtown to Bank of America’s headquarters adjacent to Bryant Park to watch Bank of America CEO Kenneth Lewis and Merrill Lynch CEO John Thain announce their hastily arranged merger. Lewis was enormously pleased with himself, basking in the attention from the New York media. I chased a tight-lipped Thain as he scurried through the lobby to get back to his headquarters. I then spent the remainder of the week working on the slightly infamous King Henry cover story on Treasury Secretary Paulson for Newsweek.

Sixty months after the failure of Lehman Brothers, many of the characters have changed. Henry Paulson is a wistful memoirist, and Tim Geithner, then the New York Fed president at the heart of the Lehman non-rescue, is working on his own book. Lewis is retired, and Thain has reinvented himself as CEO of the reinvented lender CIT Group. A lot of people have moved on. And so, too, has the U.S. economy—to a surprising degree.

The conventional wisdom holds that nothing—or at the very least, not nearly enough—has changed in the dysfunctional financial system or in the credit-addled U.S. economy. But many of the people making that argument either weren’t paying much attention to what was going on in the economy at the time or haven’t been paying much attention since. I’ll grant that the banks remain arrogant, highly leveraged, largely unrepentant, and prone to violating regulations with the same frequency and ease with which you and I have a glass of wine. But by and large, the financiers, the financial system, and American consumers all think differently about debt now.

To wit: debt in the financial sector has come down significantly. Five years ago, Lehman Brothers, an unregulated financial institution that didn’t have a base of deposits and funded itself with overnight borrowings, had about $30 of debt for every dollar of cash it had on hand. So did Bear Stearns. Giant banks like Citigroup had balance sheets that weren’t much more solid. Such species don’t exist anymore. They all got taken out in 2008. Lehman failed. Bear got eaten by JPMorgan Chase. Morgan Stanley and Goldman Sachs morphed into commercial banks and swiftly dialed down their debt levels. Merrill Lynch merged with Bank of America. And Citigroup, after taking a huge bailout, raised cash and shed assets in one of the great garage sales in Wall Street’s history. According to the Federal Reserve (see chart D. 1), financial sector debt has shrunk for each of the last four years. In the fourth quarter of 2008, the financial sector had $17.1 trillion in debt. In the first quarter of 2013, that figure stood at $13.9 trillion, off 19 percent. We may still hate the banking system. But the reality is that it is much better capitalized than it has been in years. Fewer banks are failing each year, and fewer banks are in danger of failing each quarter.

Of course, one of the undesired outcomes of the last several years has been consolidation. A few large banks now control a disproportionate share of deposits. It’s hardly surprising. We had an epic lending bubble. And consolidation is what happens in the aftermath of bubbles. The banking system pre-2008 was more diffuse and more competitive than it is today, in part because there were many more banks running around making insane loans. Check out the data (PDF) from the Federal Deposit Insurance Corporation. At the end of 2007, there were 8,534 banks in the U.S. That figure has fallen for six straight years, thanks to hundreds of failures and hundreds of mergers, as weak and struggling banks died off or fell into the arms of saviors. Today there are 6,940, down about 20 percent from the peak. Banking has a smaller cultural, retail, and employment footprint than it did several years ago. That’s different.

We may still hate the banking system. But the reality is that it is much better capitalized than it has been in years.

There’s been a fundamental change in the way consumers regard and use debt. As noted, the financial sector has reduced its use of debt. And in many important ways, so, too, has the household sector. In 2006 and 2007, the U.S. in many ways had a false economy. Hundreds of thousands of homes were bought with mortgages on which no payments were ever made, loads of clothes bought with credit cards on which payments were never made. I’ve noted this repeatedly—this is the age of the heroic American consumer. Americans are relying less on debt to consume, and they’re doing a much better job keeping up with debt. The credit card delinquency rate is at its lowest level since 1990. Credit card balances are back where they were in 2006, even though retail sales are much higher. In 2009, according to Cardhub.com, American credit card companies wrote off $83 billion in bad debt. This year, the total is likely to be about one third of that. The New York Federal Reserve’s quarterly report on household debt and credit shows that since peaking at $12.675 trillion in the third quarter of 2008, American consumers’ debt load has fallen to $11.153 trillion, a decline of $1.52 trillion, or 12 percent. That’s debt paid down, written off, or refinanced. Consumers, who account for about 70 percent of economic activity, are driving economic growth while steadily chipping away at their mountain of debt. It wasn’t like that in 2008. The relationship between debt and consumption has changed—not enough for many people’s liking, perhaps, but it has changed.

Yes, there’s much more work to do. And the bankers, like the poor, will always be with us. The large banks should be forced to hold much more capital than they do today. If they want to get bigger, they should be forced to hold even more capital. Imbalances continue to build up—especially in emerging markets and the student loan markets. And it’s quite likely we will have another financial crisis this year or next. But it won’t start in America’s housing, investment banking, and consumer debt complex, and spread throughout the world. Rather, the risk we face today is that a debt crisis in Brazil, India, or China will infect our financial system, that we’ll import a problem rather than export a problem. That’s another difference from 2008.